Posted by Don Fullerton on Aug 19, 2011

The last-minute deal between Congress and the President managed to save the day, just before the deadline, but it’s not a very specific plan. Any coherent long term plan for serious deficit reduction will still have to include cuts to defense and cuts to entitlement programs like Social Security and Medicare. But the Republicans did not want to cut defense, the Democrats did not want to cut Medicare, and they can’t cut the large portion of the Federal budget that goes to interest payments on existing debt. So instead, in the short run, they load high percentage cuts onto the small percentage of the remaining Federal budget that could be called discretionary. Thus it seems we will experience very large cuts to items like National Parks, environmental programs, highways, training, education, and social infrastructure.

If the American people really want a government that is extremely small, especially compared to other developed economies such as those in the OECD, then the deficit problem could conceivably be solved by spending cuts alone (as long as those cuts include defense and entitlements). Certainly some Tea Party Republicans want a Federal budget that small. But I suspect that some other Republicans only think they want a Federal budget that small and would change their minds once they see the decimation of so many Federal programs.

In 2009, before the current round of cuts, the United States ranked third-to-last among the 23 OECD countries for the percentage of GDP collected by government. I’m sure we would not want to match the 48% collected by some Scandinavian countries, or even the 40% collected by other European countries. Somewhere in the middle, Canada appears with 31% of GDP collected by government. The United States stood at only 24%, which exceeds only Mexico and Chile. With only spending cuts and no increase in taxes, the U.S. could soon have the smallest government among all 23 nations of the OECD. The following graph is from the Toronto Globe and Mail.

What might this mean for our state? Illinois is quite unusual, having just raised the State income tax to cover some of the growing annual deficit. Other states with new Republican governors have drastically cut spending instead of raising taxes. These actions might nudge Illinois upward, in the ranking of states by the ratio of tax collections to total state income, but it may allow Illinois to meet more of its obligations (including unfunded pension liabilities). If Illinois did not raise any taxes, it may have had to renege on some such promises.

Republicans would tell you that smaller government and a smaller tax bite is always better for job growth. But it’s a matter of degree, and a matter of balance. A state with the smallest possible budget would have very little spending on infrastructure, road quality, sanitation, police protection, education, training, and other social services. Yet many of those programs are important for businesses to be able to function properly. The trick is to find the right balance, with spending on the minimal decent level of such programs, as necessary for businesses and employees alike.

With no increase in Federal taxes, the recent deal on cuts in spending is likely to mean cuts in all kinds of Federal discretionary spending, including grants to the states. The U.S. Congress will then be likely to enact more unfunded state mandates, which means requiring the states to spend their own money to provide basic services that the Federal government used to provide. State governors and legislators will be unhappy about these changes, with even more pressure on state governments.